Most historians mark the beginning of the Great Depression event with the Market Crash of 1929. The DJIA peaked at 381 in the early Autumn of 1929. The oft-cited statistic is that if you bought in at that time, it would've taken till 1954 for you to have earned any sort of return. However, I'm not too terribly concerned about that --- I'm more curious as to how those who bought in after the initial drops fared based on the belief that they were getting a discount. For instance, if you bought in near the start of 1930 after the initial market plunge while the Dow was trading in the 240-260 range, how would you have fared? The answer is that you wouldn't have fared much better than those who bought in at the peak. It would've taken till about 1951 to earn any sort of return.

Let's say that instead of buying in on the initial drop, you bought in on the next plunge at the beginning of 1931. At that point, you could've bought in while the DJIA was in the 170-190 range. The good news is that you would've earned back all your money if you pulled out sometime near the middle of 1937. The bad news is that you basically made a 0% return for those six years. The even worse news is that if you weren't satisfied with that 0% return, you would've had to have waited until at least 1946 before making a return of about 20%. Then, there was another drop before you finally started seeing better days in the 1950s.

1931 was a very rough year for the Dow, so let's say you bought in at the end of the year instead of the beginning. You might've been able to get an entry point closer to 80 or 90 on the DJIA if you took this approach. While you still wouldn't have fared too well for the next couple of years, this would have been a reasonably good investment all the same (especially when you consider the era!). By 1934, the Dow was back in 100-110 territory, so you could've possibly earned a 15-25% return in a short time frame. If you were smart enough to hold till 1937, you could’ve sold when the Dow was in the 160-190 range, which means you would've netted a 100%+ return if you played your cards right. Of course, things went downhill again after that, but it at least looks like you would've had some good opportunities to cash in.

Finally, what would’ve happened if you bought in near the bottom in the middle of 1932? The Dow was trading in the 40-60 range at that time. If you sold off during the 1937 run-up, you could've seen your investment increase 3- to 4-fold. If you held for 25 years, all the way to 1957, you would've earned something close to a 1000% to 1200% return --- or roughly 20-28% annually. That sounds pretty good to me!

The Mid-70s Crash

In early 1973, the DJIA peaked around 1071 before it began its methodical drop. The 1973 event seems to have had more peaks and valleys in a shorter-time frame than we saw during the Great Depression-era crashes. If you bought in after the initial drop, around 900 - 930 range, you could've quickly sold off and made a return in the next few months, but if you waited longer than that, you would've had to wait till mid 1976 to make something like a 10% return. Things only got worse again after that and your next opportunity to make a profit would've been in 1981 when you would've earned roughly the same 10% return. There was even more rough sailing after that, till things finally start to pick up once you get to 1984 and you might've been able to make a 40% return by that point. Overall, you would've fared poorly no matter how you slice it.

If you waited till the beginning of 1974 plunge, you could've jumped in while the Dow was trading around 820. The results here are decidedly more mixed. Selling off in the '76 spike, you could've made a 20% return and 10% per year doesn't sound too bad during one of the biggest recessions of the past half-century! Once again, though, if you miss the window to sell in 1976, you don't make much of a return till a brief 1981 window; before you finally see clear daylight by 1984. Let's say you buy in early to mid 1974 when the DJIA is in the 650 to 700 range. You fare decidedly better. If you sold off during the '76 spike, you made somewhere in the range of a 40 to 50% return over the course of a year and a half. You never earn a negative return after that, even during all the late-70s dips. If you held all the way till 1984, you earn around a 80-95% return, so we'll say about 8.5% annually, which isn't too bad considering the time frame. If you hold for 25 years all the way till 1999, you earn somewhere around a 1400% return or roughly 50-60% annually! Not too shabby, eh?

Given the success of our last scenario, I hardly need to mention what happened if you got in at the bottom in the 580 to 610 range. The interesting thing about this, however, is that even if you sold off during one of the late '70s plunges, you don't fare all that poorly. If you sold off near the beginning of '78 during the worst dip, you still would've made a 27% return or approximately 7-8% annually.

The Black Monday Crash of 1987

The 1987 event ends up being markedly less severe than the other two events we examined. If you bought in about halfway through the downturn when the DJIA was at 2250, it would've taken about a year and a half to earn a positive return. By mid-1990, you could've seen roughly a 25% return. If you held on through the '90s, obviously that return would've been upped considerably.

If you bought in closer to the bottom near the 1800 level and sold off somewhere in the middle of the 1991 build-up, you would've netted a return of about 35% - 40%, which isn't horrible. Even with the market downturn, if you held all the way to the present day, you would've earned a return around 400% or about 19% annually. That sounds like a good investment!

The Prognosis

The simple lesson here is to buy in at the bottom --- but everyone already knew that! The more difficult lesson is learning how to gauge where the bottom will be and how well or how poorly you'll fare if you mistime it. The Great Depression and the 1973-74 market crash event provide sobering examples of how things can be sour for a considerable period of time if you buy in too soon. However, we also see how massively one can profit even if they buy in a little bit before the market hits the floor. Perhaps this simply suggests that the safest route is to slowly buy in and gradually accelerate buying habits as the market continues to drop. Of course, when you consider the fact that nearly 90% of the equity in the market was destroyed in the first three years of the Great Depression, that's a very frightening thought. Which begs the question: “is this a second coming of the Great Depression?" Each individual investor has to decide that for his or her self.

From my viewpoint, the current market crash event differs considerably from the Great Depression. One of the major reasons for the massive run-up in the market during the late 1920s was speculation on a grand scale. While there will always be speculation, it seems that this crisis is less about that and more about market fundamentals and lending policies in the financial sector.

Taking a look at stock prices of S&P 500 companies and comparing them to earnings, balance sheets, and cash flows seems to produce many attractive bargains out there. To be sure, earnings will decline as the recession is prolonged and possibly turns into a depression, but at the very least, valuations do not appear to be so out-of-whack that one would expect the Dow to fall another 5,000 points before finding a floor. For that reason, I tend to view the current market events as being more analogous to the prolonged crash event of 1973 – 74 and would be surprised to see the DJIA dip far below 7,000. Of course, that doesn't mean we'll see smooth sailing again any time soon.

While only time will tell, my best guess as to where the bottom lies is around 8,000. All the same, I'm ready to start buying in.

So, as you successfully illustrate, 7-8% return a year on average on equity is a myth. It only works if you manage time the market more or less. Buy and hold doesn't work and that is that. I can't beleive the US forces people to provide for their retirement through gambling in a stock market. Most people are not good gamblers. They do exactly the wrong thing.Moreover, they are restricted to long only side. And dare I say, for most of people there is not going to be a retirement on their 401K.

With all this mess, how is it anybody wants to be a president of the US? I would never agree even if I was offered it on a plate. Who needs this kind of responsibility? Look at Henry Paulson, he has a sinking feeling, I am sure, that he cannot fix the situation , but he is obligated to try all the same.

The only sinking feeling that Paulson has is that he was caught with the 'hot potato'. Paulson has banked millions off of a fraudulent system...and like most smart people...the bulk of his money is not invested in volitile areas. That gameplay is reserved for the publics money and retirement funds.

At the end of the day, Paulson is still wealthy, and will remain wealthy. He is fighting hard to save his buddies and come out looking like a hero...at least to them...which is his only concern. Like most of the wealthy and arrogant...as long as he's got his money, he gould give a $hit less what anybody outside of his circle thinks about his performance.

P.S. Noone is forced to put their retirement in the stock market. They have just been misled for years thatthis was a sound arena to grow your retirement.

Aweseome blog post Huney. Wish there was more of this type of analysis around here as opposed to regurgitation of others' blogs and news items. Wish I could give you 5 recs for this one.

The take home moral, as I see it, is to keep buying on the way down, and to especially focus on dividend stocks. It's impossible to ever time the bottom, but if you DCA down through auto investing and dividends, it seems like you come out ahead. I do agree that market timing and selling off on big runups is somewhat necessary - I've preserved my capital (mostly) by selling off my biggest positions in the past year.

Also, if you buy real good companies, you can come out way ahead. MO increased 600% (solely on share price appreciation) in the 1970s. If you had bought GM in the 1970s and still were holding today, you can't say that's a good investment. However, for the indexers out there, this is a good analysis. At some point I'll probably re-initiate an index position (although in my Roth I'm still holding spartan 500, in my taxable accounts I timed the market fairly well and made about a 45% return from 2003-2007 on my index funds), but as of right now I don't think we're at a long-term bottom. We've finally reached capitulation, and now the panic is starting - I need to see a bit more panic before I start buying en masse, although I do think right now is a good time to buy strong companies that have been beaten down with the market (PM, MMM, MO, JNJ, POT, COP, etc.)

Great post. You definitely have the right idea. Buy low and hold patiently for a while.

It's funny how many people you hear yelling "buy buy buy" when the market is getting near its top. Then when the Dow has just lost about 5000 pts in the past several months, you hear people telling you to panic. I say tell them to go jump in the lake. If they knew what they were talking about they wouldn't have been yelling "buy" when the Dow was 5000 pts higher.

The bottom line is I can guarantee you one thing: It is better to buy now than it was when the Dow was at 14,000.

Excellent post. It really helps to get things into perspective. I have been feeling very greedy looking at how cheap prices are compared to what I was used to, and acting on it no less. In all of the examples you provide, it seems that waiting it out is the better way to go, not jumping in on the first big drop. We are only a few weeks into this major turn of events. Buying now could turn into a very long waiting game, better have a solid dividend coming in. Third quarter results will likely cause much more pain as will first quarter 09 results. As written above the Holiday season sales will be terrible, the average U.S. citizen has only just now become aware that there is a problem, they will begin clamping down on their spending starting now.

Great post, Huney. Just the information I was looking for. End of last year, I thought of selling my portfolio when it looked like market was getting ahead of itself. I am glad I finally cleared my portfolio a couple of months ago. But "Buy & Hold" got the better of me. I think the appropriate term should be "Buy low and hold" or "Buy & Hold only as long as fiundamentals are sound". I started building a small position a month ago and will add to it. Today looks like a good day though now looking at your post, I should probably do this with caution. I doubt the position will give a return any time soon but then I can hold (as long as fundamentals are in favor)

Another way to look at this (from a very rough perspective) is as follows. Before the banking/financial deregulations of late 1999 and 2000 went into effect, the financial industry accounted for 12% of GDP. With the deregulations in place, that sector ballooned to 28% of GDP, a huge piece of the American pie. If we were to wash the greed and over-leveraging out of the system back to pre-GLBA standards, that 16% drop in GDP would knock the DJIA down to at least 75% of what it was at its high (12/16 = 75%). And that's from the financial sector alone! The effects of the shenanighans these businesses have been involved with will certainly have an adverse impact of other businesses, great and small.

Obviously in reaching 8451 today, we've already seen that 25% drop, but I believe there is still a bit more coming. Like you, I am anxious to start buying but I am going to be a bit more patient this time, waiting for the floor to be solid. I think we are going to be on this floor for awhile before moving upwards with any consistency.

I'm definitely in agreement in regards to being on the floor for awhile before going back upwards to any significant degree. I think this will be one of the worser recessions experienced in the past half-century in America.